The Official Blog Of Larry Berman - CFA, CMT, CTA

When the Outlook is Not Clear, We Have Options!

I’ve been asked several times over the past week what happens if Trump sweeps vs. loses both houses of Congress. What if the pollsters are wrong like they were about Trump in 2016. According to Nate Silver of www.fivethirtyeight.com , the guy who was very accurate before 2016 at predicting and very wrong in 2016 about BREXIT and Trump, we would have to see a statistical fluke in the polling with odds of 1 chance in 80 that Congress does not split.

The most likely outcome based on the pollsters is gridlock where the GOP gains a few seats in the Senate but loses control of the House. In that scenario, that the market expects, we can expect the focus to remain mostly on Trade with China for the next few months. In the odd case that something else happens, we can expect a test of the price extremes of recent months. The market would initially cheer a GOP sweep and we would rally, but I’d be shocked if we could see new highs. The market would like more middle class tax cuts and infrastructure spending some time in 2020. More control by the Dems, could see last week’s lows retested, but doubtful that we would go much lower. The Dems want infrastructure spending too. In either case, the Fed may need to be more aggressive. Gridlock, at this point, the most likely scenario, would be best for market stability.

Good news, you have options.

There are basically 4 ways that you can take a position with ETFs.

Position

Return

Risk

Long ETF

MAX (HIGH)

MAX (HIGH)

Long ETF + CC

LIMITED

REDUCED

Sell ATM PUT + MM ETF

LIMITED

REDUCED

Sell OTM PUT + MM ETF

MINIMUM

LOWEST

Writing puts to buy positions is one of my favourite strategies when you are less certain about the outlook to generate yield while you are waiting.

The low last week for the S&P 500 (SPY) ETF was a bit below 260 and represents a good short-term entry point. Writing a put for Nov 16 yields 1.11 or 1.11/271.89 = 0.41% (over the next 11 days) % and 3.89 (1.43%) to Dec 31th plus what you would earn on your cash (about 2% annualized, so 0.17% monthly). If you were worried about a more major decline in 2019/2020 recession decline (I think 1800 is a good downside potential), selling a 180 PUT for Dec 2019 to buy the market at 1800 yields and extra 0.81% on top of 2%+ in a money market ETF like SHV. You can generate a near 3% return over the next year, which is well more than the 1.9% dividend the S&P 500 while sleeping at night a bit better. Those of you with FEAR OF MISSING OUT ANXIETY (FOMO) meanings you can’t stand not keeping up with market returns. Emotional responses like this will inevitably kill your long term returns because you will at some point start chasing the market with a LONG position rather than strategically investing for the risk levels you are more comfortable taking.

Using options can limit your upside, but it enhances your yield while you rest easy. Out of the Money (OTM) PUT-WRITE strategies work best when sideways to lower or for slow growth in the market overall. In this example we created on Aug 30th to demonstrate what happens to these strategies during high volatility periods, we created a portfolio for each strategy to compare. The SPY closed that days at 290.30. The SPY 290 PUT for DEC 21, 18 was at $7.86 or a yield of 2.89%%. The SPY CALL for DEC was $8.14 for a yield of 2.99%. The 5% OTM DEC 276 PUT was trading at $4.23 or a yield of 1.56%. With options yields, most of the value is realized in the last week or two as the time decay really kicks in.

A key strategy with these types of positions is your ability to change. Once the market sells off to the level you are comfortable taking the LONG risk, then buy back your put and GO LONG young man (or woman)!

Our fall roadshow dates are out. Come out and find out how to profit while protecting in the longest bull market of all-time, where I will look at some of my top sector ETF picks for the next few years and teach you how to build balanced portfolios using less risky options strategies that will work better in the next few years. Click here to register for free and as always we ask for volunteer donations to one of our two favourite charities. Children’s cancer research at the Sick Kids Hospital and Alzheimer’s and dementia research at the Baycrest Hospital.

About the authorLarry Berman

Larry Berman is a Co-Founder of ETF Capital Management and the Prosper Experiential Media. Over his 25 year career, Larry has worked for numerous top firms in New York, Boston, and Toronto. Prior to founding ETFCM (2006), he was Chief Technical Strategist and Managing Director for CIBC World Markets for nearly a decade where he was ranked as one of Canada’s “Top 3 Analysts” according to Brendan Wood institutional investor surveys. READ MORE